The controversial VAT treatment of TP adjustments

In an ever-changing cross-border economic scenario, TP adjustments made to ensure compliance with the arm’s length principle applicable for transfer pricing purposes are particularly important, including in the field of VAT. Where such adjustments are relevant for VAT purposes, any failure to comply with the related obligations may give rise to penalties.

The rules governing transfer pricing adjustments stem from the need to ensure that intercompany transactions comply with the arm’s length principle, namely that they be carried out under the same conditions as those that would have been agreed between independent parties operating under comparable circumstances. This principle is laid down internationally in Article 9(1) of the OECD Model Tax Convention and domestically in Article 110(7) of the Italian Income Tax Code (TUIR).

While the analysis of the relevant rules is more clearly defined in relation to direct taxes, the same cannot be said for indirect taxes, particularly concerning the VAT implications of transfer pricing adjustments.

In this regard, it should first be noted that the primary objective of transfer pricing rules is to ensure the proper allocation of income among companies belonging to the same group. Conversely, the primary objective of VAT is to tax the consumption of goods and services in accordance with the principle of tax neutrality.It follows that transfer pricing adjustments do not automatically affect the determination of the VAT taxable amount, which remains independently linked to the payment actually agreed between the parties.

At the EU level, the issue of TP adjustments has been examined since 2017, with the publication of Working Paper No. 923 by the European Commission, followed in 2018 by an additional document issued by the VAT Expert Group. According to the EU approach, while adjustments arising from tax assessments are generally irrelevant for VAT purposes, voluntary adjustments made independently by taxpayers are irrelevant only where they are aimed exclusively at rebalancing profitability among group companies without directly affecting either the agreed price or the individual transactions carried out (“profit adjustments”). Conversely, a voluntary adjustment is relevant for VAT purposes where three cumulative conditions are met: (i) a payment exists, (ii) the transactions related to the payment are identifiable, and (iii) there is a direct link between the service supplied and the payment received.

These principles have been substantially endorsed by the Court of Justice of the European Union, which, in Case C-726/23, Arcomet, held that the remuneration of services rendered in an intercompany context in order to align the profitability of an associated enterprise with the arm’s length standards laid down by transfer pricing rules constitutes the payment for a taxable supply of services for VAT purposes.

Over time, the Italian Tax Authority (ITA) has also adopted the principles developed at EU level, as clearly reflected in a series of tax rulings concerning the VAT treatment of TP adjustments.

Therefore, in these tax rulings, the ITA's approach appears to be substantially aligned with the guidance of the European Commission, as it assigns a central role to contractual arrangements and to the transfer pricing policy in determining the correct VAT treatment of such adjustments.

Penalty profiles

The main penalty should be linked exclusively to the incorrect application of the reverse charge mechanism, given that such transactions generally fall under the reverse charge regime.

In this regard, Article 6, paragraph 9-bis, of Legislative Decree No. 471/1997 provides for an administrative penalty ranging from €500 to €10,000 for the transferee or customer who fails to comply with the obligations related to the reverse charge. Furthermore, if the transaction is not recorded in the accounts, the penalty amounts to 5% of the taxable amount, with a minimum of €1,000.

In conclusion, given the growing complexity of intercompany transactions and the importance of the VAT implications related to transfer pricing adjustments, it is desirable that the ITA provide a systematic framework for this issue. A step in this direction would not only align Italy with international best practices, but would also ensure certainty and transparency for businesses, helping to mitigate the risk of penalties.